Tag: Financial Statements

Management Notes

Amortization, Characteristics, Entries

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Amortization refers to the systematic allocation of the cost of an intangible asset (e.g., patents, copyrights, goodwill) or the repayment of a loan principal over its useful life or loan term. For intangible assets, it follows the matching principle in accounting, spreading the expense to align with the revenue it generates. Unlike depreciation (for tangible assets), amortization typically uses the straight-line method, assuming equal expense distribution each period. For loans, amortization involves gradual principal repayment through periodic installments, reducing the outstanding balance over time. It impacts financial statements by lowering asset book value (balance sheet) and recording periodic expenses (income statement). Under IFRS and GAAP, amortization stops if the asset’s residual value is reassessed or impaired. Proper amortization ensures accurate profit measurement and compliance with accounting standards.

Characteristics of Amortization:

  • Gradual Allocation of Cost

Amortization involves systematically allocating the cost of an intangible asset over its useful life. Instead of recording the full expense at once, the cost is divided into equal or appropriate portions for each accounting period. This gradual recognition ensures that the expense matches the periods in which the asset contributes to revenue generation. By spreading the cost, amortization prevents sudden impacts on profits and provides a more accurate picture of an entity’s financial performance, aligning with the matching principle in accounting.

  • Applicable to Intangible Assets

Amortization is specifically applied to intangible assets such as patents, trademarks, copyrights, franchises, goodwill, and software. These assets lack physical substance but provide long-term benefits to a business. The process helps in systematically reducing their book value until it reaches zero or their residual value, whichever is applicable. Unlike depreciation (for tangible assets), amortization only applies to non-physical assets and usually uses the straight-line method unless otherwise specified. It reflects the consumption or expiration of the economic benefits embedded in intangible assets.

  • Non-Cash Expense

Amortization is a non-cash expense, meaning it does not involve any actual cash outflow during the accounting period. The cash payment for acquiring the intangible asset is made upfront or in installments, but amortization simply spreads that cost in the books over time. This characteristic makes it important in financial analysis because it reduces reported profits without affecting cash flows. It helps stakeholders distinguish between accounting expenses and actual cash expenditures, thus aiding in more accurate cash flow management and analysis.

  • Based on Useful Life

The amount of amortization depends on the useful life of the intangible asset, which is the period over which it is expected to generate economic benefits. This useful life is estimated based on legal, contractual, or economic factors. For example, a patent might have a legal life of 20 years but could be amortized over 10 years if the company expects to benefit from it only during that period. Amortization stops when the asset is fully amortized or disposed of.

  • Matches Expenses with Revenue

Amortization follows the matching principle in accounting, which requires expenses to be recorded in the same period as the revenues they help generate. By allocating the cost of intangible assets over their useful lives, amortization ensures that financial statements accurately reflect the cost of using these assets in generating income. This leads to fairer and more consistent profit measurement across accounting periods, preventing overstatement of income in earlier years and understatement in later years when benefits are still being received.

  • Straight-Line Method Preference

In most cases, amortization is calculated using the straight-line method, which allocates an equal amount of expense in each period of the asset’s useful life. This approach is preferred because intangible assets often provide consistent benefits over time. However, other methods can be used if the asset’s benefits are consumed unevenly. The choice of method should reflect the pattern in which economic benefits are derived. The straight-line method’s simplicity, predictability, and ease of calculation make it the most widely adopted practice.

Entries of Amortization:

S. No. Situation Journal Entry Explanation

1

Recording amortization expense

Amortization Expense A/c Dr.

  To Accumulated Amortization A/c

Records the amortization amount for the period, reducing the value of the intangible asset over time.

2

Directly reducing asset value

Amortization Expense A/c Dr.

  To Intangible Asset A/c

Used when amortization is directly deducted from the asset account rather than accumulated separately.

3

At year-end transfer of expense to Profit & Loss

Profit & Loss A/c Dr.

  To Amortization Expense A/c

Transfers amortization expense to P&L, reducing net profit for the period.

4

Fully amortizing an asset

Accumulated Amortization A/c Dr.

  To Intangible Asset A/c

Removes the asset’s cost and related accumulated amortization upon completion of its useful life.

5

Amortization in case of disposal of asset

 Bank A/c Dr.

Accumulated Amortization A/c Dr.

  To Intangible Asset A/c

  To Gain on Disposal A/c (if any)

Records disposal, removes asset’s cost, accumulated amortization, and recognizes any gain.

6

Loss on disposal

 Bank A/c Dr.

Accumulated Amortization A/c Dr.

Loss on Disposal A/c Dr.

  To Intangible Asset A/c

Records loss when sale proceeds are less than the net book value.
Management Notes

Basis of Accounting, Cash basis and Accrual Basis

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Basis of Accounting refers to the method by which financial transactions are recorded and recognized in the accounting system. There are two primary types: Accrual Basis and Cash Basis. Under the accrual basis, revenues and expenses are recognized when they are earned or incurred, regardless of cash flow. The cash basis, on the other hand, records transactions only when cash is received or paid. The choice of accounting basis affects how financial performance and position are reported and can impact decision-making and analysis.

Cash basis

Cash Basis Accounting is a simple method where revenues and expenses are recorded only when cash is actually received or paid. In this system, income is recognized when cash is collected, and expenses are recognized when payments are made, regardless of when the transaction occurred. It is commonly used by small businesses and individuals due to its simplicity and focus on actual cash flow. However, it may not provide a complete picture of a business’s financial health, as it ignores receivables, payables, and other non-cash transactions.

Functions of Cash basis:

  • Simple and Easy to Use:

One of the main functions of cash basis accounting is its simplicity. It requires no complex financial tracking or extensive knowledge of accounting principles. Businesses record income when cash is received and expenses when payments are made. This ease of use makes it particularly attractive for small businesses, freelancers, and sole proprietors with limited accounting resources.

  • Focuses on Cash Flow:

Cash basis accounting emphasizes actual cash flow, helping businesses closely monitor their available cash. Since it records only when cash is received or spent, businesses can easily see how much cash they have on hand. This is critical for small businesses or startups that rely on maintaining positive cash flow for their day-to-day operations and short-term decision-making.

  • Immediate Recognition of Transactions:

In cash basis accounting, transactions are recognized immediately upon receipt or payment of cash. This function simplifies financial record-keeping, as there is no need to track receivables, payables, or adjust for accruals. As a result, business owners can directly link their bank statements to their accounting records, creating a clear and straightforward financial picture.

  • Lower Administrative Costs:

Cash basis accounting typically requires less administrative effort and fewer resources than accrual accounting. It eliminates the need for tracking accounts receivable, accounts payable, and making complex adjustments. This function reduces bookkeeping time and costs, making it an affordable option for small businesses without the need for extensive accounting departments.

  • Tax Benefits:

In many tax systems, cash basis accounting can offer potential tax benefits. Since income is recognized only when cash is received, businesses may be able to defer income tax liability if payments from customers are delayed until the next tax year. This can help manage tax obligations and smooth out cash flow, especially for businesses with fluctuating income.

  • Provides a Clear Picture of Immediate Liquidity:

Cash basis accounting gives an accurate view of a company’s current liquidity. Since it only records cash transactions, it shows exactly how much cash is available at any given time. This function is particularly useful for businesses needing to make short-term decisions based on available resources.

  • Reduces Complexity in Financial Reporting:

With cash basis accounting, there are no complex financial reports to prepare. There are no accruals, prepayments, or provisions to account for, reducing the complexity of financial statements. For smaller businesses, this function means less reliance on professional accountants or financial experts, simplifying reporting and compliance.

  • Better for Small or Cash-Based Businesses:

Cash basis accounting functions well for businesses that operate primarily on a cash basis, such as retail stores, food service providers, and small service-oriented businesses. Since these businesses receive payments immediately and have minimal credit sales or long-term receivables, cash basis accounting aligns well with their operations, making financial management straightforward and efficient.

Cash basis Book entry:

Date Transaction Debit Credit Description
YYYY-MM-DD Cash Sale Cash Sales Revenue Cash received from sales.
YYYY-MM-DD Cash Purchase Purchases Cash Cash paid for inventory or supplies.
YYYY-MM-DD Cash Received from Customer Cash Accounts Receivable Cash received for previously sold goods.
YYYY-MM-DD Cash Payment to Supplier Accounts Payable Cash Payment made to supplier for outstanding bills.
YYYY-MM-DD Cash Expense Payment Expenses Cash Cash paid for operating expenses (e.g., rent).
YYYY-MM-DD Owner’s Capital Contribution Cash Owner’s Equity Cash invested into the business by the owner.
YYYY-MM-DD Cash Withdrawal for Personal Use Owner’s Equity Cash Cash withdrawn by the owner for personal use.
YYYY-MM-DD Loan Received Cash Loan Payable Cash received from a loan.
YYYY-MM-DD Loan Payment Loan Payable Cash Cash payment made towards loan repayment.
YYYY-MM-DD Cash Dividend Distribution Retained Earnings Cash Cash dividends paid to shareholders.

Accrual Basis:

Accrual Basis Accounting is a method where revenues and expenses are recorded when they are earned or incurred, regardless of when cash is actually received or paid. Under this system, revenue is recognized when goods or services are delivered, and expenses are recorded when obligations arise. This method provides a more accurate picture of a company’s financial performance by matching revenues with related expenses within the same accounting period. While more complex than cash basis accounting, it is widely used by larger businesses and follows generally accepted accounting principles (GAAP).

Functions of Accrual basis:

  • Matching Principle:

One of the primary functions of accrual basis accounting is the matching principle, which states that revenues should be matched with the expenses incurred to generate them within the same accounting period. This function allows businesses to accurately assess profitability by linking income with its associated costs, providing a clearer picture of financial performance.

  • Comprehensive Financial Reporting:

Accrual accounting enhances financial reporting by providing a complete view of a company’s financial activities. It includes not only cash transactions but also accounts receivable and payable, ensuring all financial obligations and rights are recognized. This comprehensive reporting is crucial for stakeholders who need to evaluate a company’s performance over time.

  • Improved Financial Forecasting:

By recognizing revenue and expenses when they occur, accrual basis accounting allows for better financial forecasting and planning. Businesses can analyze trends and patterns based on actual performance rather than cash flow timing. This function is particularly beneficial for long-term strategic planning and investment decisions.

  • Enhanced Creditworthiness:

Companies using accrual accounting can present a more accurate picture of their financial health, improving their creditworthiness. Lenders and investors often prefer accrual basis financial statements because they reflect all obligations and income, not just cash transactions. This transparency can lead to better financing options and terms.

  • Facilitates Compliance with Standards:

Accrual basis accounting complies with generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). Many public companies are required to use this method for financial reporting. This function ensures that businesses meet regulatory standards and enhances the reliability and comparability of financial statements.

  • Management of Receivables and Payables:

Accrual accounting requires businesses to track accounts receivable and accounts payable, providing insights into outstanding debts and future cash inflows. This function helps businesses manage cash flow more effectively, ensuring they can meet their obligations while maximizing revenue collection.

  • Historical Financial Analysis:

Accrual basis accounting enables more effective historical financial analysis by providing a consistent view of revenues and expenses over time. Businesses can analyze trends, assess long-term performance, and make informed decisions based on historical data, leading to more strategic growth initiatives.

  • Supports Investment Decisions:

Investors rely on accrual basis financial statements for making informed investment decisions. The recognition of revenue and expenses at the time they are earned or incurred provides a more accurate representation of a company’s operational performance. This function helps investors assess potential risks and returns effectively.

Accrual basis Book entry:

Date Transaction Debit Credit Description
YYYY-MM-DD Sale on Credit Accounts Receivable Sales Revenue Revenue recognized when goods/services are delivered.
YYYY-MM-DD Purchase on Credit Purchases Accounts Payable Expense recognized when goods/services are received.
YYYY-MM-DD Payment Received for Accounts Receivable Cash Accounts Receivable Cash received for previously recognized revenue.
YYYY-MM-DD Payment Made to Supplier Accounts Payable Cash Payment for previously recognized expense.
YYYY-MM-DD Accrued Salaries Salary Expense Accrued Salaries Payable Salary expense recognized before payment.
YYYY-MM-DD Accrued Interest Expense Interest Expense Accrued Interest Payable Interest expense recognized as incurred.
YYYY-MM-DD Depreciation Expense Depreciation Expense Accumulated Depreciation Depreciation recognized for the accounting period.
YYYY-MM-DD Unearned Revenue Cash Unearned Revenue Cash received in advance; revenue recognized later.
YYYY-MM-DD Expense Prepaid Prepaid Expense Cash Expense paid in advance; recognized over time.
YYYY-MM-DD Adjusting Entry for Accruals Various Expenses Various Payables Adjustments made for accrued or deferred items.

Key differences between Cash basis and Accrual Basis

Aspect Cash Basis Accrual Basis
Revenue Recognition Cash Received Earned
Expense Recognition Cash Paid Incurred
Complexity Simple Complex
Financial Reporting Limited Comprehensive
Matching Principle Not Applicable Applicable
Cash Flow Focus Yes No
Tax Implications Immediate Deferred
Usage Small Businesses Larger Businesses
Accounts Receivable Not Recorded Recorded
Accounts Payable Not Recorded Recorded
Timeframe Current Future/Current
Regulatory Compliance Limited Required
Financial Insights Short-term Long-term
Investment Analysis Limited Enhanced

 

Management Notes

Changes in accounting estimate

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When accounting for business transactions, there will be times when an estimate must be used. In some cases, those estimates prove to be incorrect, in which case a change in accounting estimate is warranted. A change in estimate is needed when there is a change that:

  • Alters the subsequent accounting for existing or future assets or liabilities.
  • Affects the carrying amount of an existing asset or liability.

Changes in estimate are a normal and expected part of the ongoing process of reviewing the current status and future benefits and obligations related to assets and liabilities. A change in estimate arises from the appearance of new information that alters the existing situation. Conversely, there can be no change in estimate in the absence of new information.

Applying changes in accounting policies

(i) An entity shall account for a change in accounting policy resulting from the initial application of an Ind AS in accordance with the specific transitional provisions, if any, in that Ind AS; and

(ii) when an entity changes an accounting policy upon initial application of an Ind AS that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively.

Examples of Changes in Accounting Estimate

All of the following are situations where there is likely to be a change in accounting estimate:

  • Reserve for obsolete inventory
  • Allowance for doubtful accounts
  • Changes in the useful life of depreciable assets
  • Changes in the amount of expected warranty obligations
  • Changes in the salvage values of depreciable assets

Changes in accounting estimates

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of:

(a) Bad debts

B) Inventory obsolescence

(c) The fair value of financial assets or financial liabilities

(d) The useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets

 (e) Warranty obligations.

When there is a change in estimate, account for it in the period of change. If the change affects future periods, then the change will likely have an accounting impact in those periods, as well. A change in accounting estimate does not require the restatement of earlier financial statements, nor the retrospective adjustment of account balances.

If the effect of a change in estimate is immaterial (as is usually the case for changes in reserves and allowances), do not disclose the alteration. However, disclose the change in estimate if the amount is material. Also, if the change affects several future periods, note the effect on income from continuing operations, net income, and per share amounts.

Management Notes

Derivatives and Hedge Accounting

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Derivatives Accounting

A derivative is a financial instrument whose value changes in relation to changes in a variable, such as an interest rate, commodity price, credit rating, or foreign exchange rate. There are two key concepts in the accounting for derivatives. The first is that ongoing changes in the fair value of derivatives not used in hedging arrangements are generally recognized in earnings at once. The second is that ongoing changes in the fair value of derivatives and the hedged items with which they are paired may be parked in other comprehensive income for a period of time, thereby removing them from the basic earnings reported by a business.

The essential accounting for a derivative instrument is outlined in the following bullet points:

  • Initial recognition. When it is first acquired, recognize a derivative instrument in the balance sheet as an asset or liability at its fair value.
  • Subsequent recognition (hedging relationship). Recognize all subsequent changes in the fair value of the derivative (known as marked to market). If the instrument has been paired with a hedged item, then recognize these fair value changes in other comprehensive income.
  • Subsequent recognition (ineffective portion). Recognize all subsequent changes in the fair value of the derivative. If the instrument has been paired with a hedged item but the hedge is not effective, then recognize these fair value changes in earnings.
  • Subsequent recognition (speculation). Recognize in earnings all subsequent changes in the fair value of the derivative. Speculative activities imply that a derivative has not been paired with a hedged item.

The following additional rules apply to the accounting for derivative instruments when specific types of investments are being hedged:

  • Trading securities. This can be either a debt or equity security, for which there is an intent to sell in the short term for a profit. When this investment is being hedged, recognize any changes in the fair value of the paired forward contract or purchased option in earnings.
  • Held-to-maturity investments. This is a debt instrument for which there is a commitment to hold the investment until its maturity date. When such an investment is being hedged, there may be a change in the fair value of the paired forward contract or purchased option. If so, only recognize a loss in earnings when there is an other-than-temporary decline in the hedging instrument’s fair value.
  • Available-for-sale securities. This can be either a debt or equity security that does not fall into the held-to-maturity or trading classifications. When such an investment is being hedged, there may be a change in the fair value of the paired forward contract or purchased option. If so, only recognize a loss in earnings when there is an other-than-temporary decline in the hedging instrument’s fair value. If the change is temporary, record it in other comprehensive income.

Rules for Accounting Derivatives

Accounting of derivatives is based upon the purpose for which it is used as it can be used for speculation, i.e. to earn profit from derivatives transactions and hedging, i.e. to control the risk of future contracts. Suppose there is speculation loss that is to be recognized immediately in the accounts.

Some of the rules for Accounting of derivatives are as under:

  • Initially, derivatives are to be recorded at fair value.
  • Re-measurement of fair value is to be done at the end of the financial year or at the end of the contract period, whichever falls earlier.
  • The purpose of the derivative is to be determined at the time of entering so as to decide whether it is speculation or hedging.
  • Any transaction cost for entering into derivatives is to be charged to the profit and loss account immediately.
  • If the derivative is of speculation in nature, the loss or profit is to be immediately recognized in the profit and loss account.
  • If the derivative is non-speculative, the loss or gain is to be transferred to a comprehensive income account.
  • Journal entries of accounting for derivatives are:
Date Particulars Debit ($) Credit ($)
On entering into a transaction for an underlying derivative asset:
Forward Asset A/c                 Dr. XXX
                      To Bank/ Creditor A/c XXX
(Being underlying asset purchased by entering into a derivative contract)
Increase in fair value of forward asset resulting in a gain
Forward Asset A/c                      Dr. XXX
                      To Forward value gain A/c XXX
(Being increase in the value of forward asset results in gain)
Decrease in fair value of asset resulting in loss
Fair Value Loss A/c                         Dr. XXX
               To Forward Asset A/c XXX
(Being Decrease in value of asset resulted loss in forward contract)
Settlement of Forward contract
Creditor/ Bank A/c                             Dr. XXX
                     To Forward Asset A/c XX
                     To Profit and Loss A/c XX
(Being Forward contract settled and net gain or loss is transferred to profit and loss A/c)  

Hedge Accounting

Hedge accounting is an accountancy practice, the aim of which is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. There are two types of hedge recognized. For a fair value hedge, the offset is achieved either by marking-to-market an asset or a liability which offsets the P&L movement of the derivative. For a cash flow hedge, some of the derivative volatility is placed into a separate component of the entity’s equity called the cash flow hedge reserve. Where a hedge relationship is effective (meets the 80%–125% rule), most of the mark-to-market derivative volatility will be offset in the profit and loss account. Hedge accounting entails much compliance involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.

Under IAS 39, derivatives must be recorded on a mark-to-market basis. Thus, if a profit is taken on a derivative one day, the profit must be recorded when the profit is taken. The same holds if there is a loss on the derivative.

If that derivative is used as a hedging tool, the same treatment is required under IAS 39. However, this could bring plenty of volatility in profits and losses on, at times, a daily basis. Yet, hedge accounting under IAS 39 can help decrease the hedging tool’s volatility. However, the treatment of hedge accounting for hedging tools under IAS 39 is exclusive to derivative instruments.

A specific type of hedging transaction that entities can engage in aims to manage foreign currency exposure. These hedges are undertaken for the economic aim of reducing potential loss from fluctuations in foreign exchange rates. However, not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated forex hedges:

  • A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction.
  • A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.
  • A net investment hedge may be designated for the net investment in a foreign operation.

There are three main asset categories that companies use hedge accounting for:

Foreign currency exposures: For transaction exposures, such as forecasted purchases, revenues and expenses in foreign currencies, as well as foreign-currency-denominated assets and liabilities.

Interest rate exposures: Such as forecasted fixed-rate borrowing, variable-rate assets and liabilities, as well as fixed-rate assets and debt.

Commodity exposures: These include forecasted purchases, sales and inventory.

Accounting standards enable hedge accounting for three different designated categories:

Cash flow hedge: Designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognised asset or liability, or a forecasted intercompany transaction.

Fair value hedge: Designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.

Net investment hedge: Designated for the net investment in a foreign operation.

Management Notes

Impairment, Asset Retirement Obligation

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Impairment

In accounting, the decrease in the net asset value of an asset due to the carrying amount of the asset exceeding the recoverable amount thereof. The effect of impairment constitutes the decrease in asset values per the Statement of Financial Position and a corresponding amount recognised through profit or loss in respect of the impairment loss.

Impairment describes a permanent reduction in the value of a company’s asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company’s balance sheet.

Impairment is commonly used to describe a drastic reduction in the recoverable amount of a fixed asset. Impairment may occur when there is a change in legal or economic circumstances surrounding a company or a casualty loss from unforeseen devastation.

Factors could lead to the value of the asset declining:

Change in legal climate: It’s also possible that a lawsuit, court case, or some other change to the general business/legal climate could cause a reduction in value of the asset. For example, if a worker gets injured while using your equipment and sues your company, you may not be able to use the asset until the legal situation is resolved.

Market downturn: If the market takes a dip, then the fair market value of an asset may end up being less than its book value. For example, if the real estate market experiences a downturn, then any land or property that you’re holding as an asset could decline in value.

Escalating costs: You may experience a situation where the running costs to maintain an asset are more than you were expecting when you made the initial investment, or the running costs have simply escalated over time, leading to a reduction in overall value.

Impairment vs. Depreciation and Amortization

Impairment of assets may sound similar to the accounting processes of depreciation and amortization (a reduction in the value of an asset over the course of its useful life). While there are some relatively clear similarities between the two concepts, there’s one key distinction: impairment denotes a sudden, irreversible drop in value, whereas depreciation/amortisation reduces the value of the asset over its entire lifetime. So, whereas impairment accounts for unusual drops in an asset’s value, depreciation and amortisation is generally used for standard wear and tear.

Fixed assets, such as machinery and equipment, depreciate in value over time. The amount of depreciation taken each accounting period is based on a predetermined schedule using either straight line or one of multiple accelerated depreciation methods. Depreciation schedules allow for a set distribution of the reduction of an asset’s value over its entire lifetime. Unlike impairment, which accounts for an unusual and drastic drop in the fair value of an asset, depreciation is used to account for typical wear and tear on fixed assets over time.

Asset Retirement Obligation

An Asset Retirement Obligation (ARO) is a legal obligation associated with the retirement of a tangible long-lived asset in which the timing or method of settlement may be conditional on a future event, the occurrence of which may not be within the control of the entity burdened by the obligation. In the United States, ARO accounting is specified by Statement of Financial Accounting Standards (SFAS, or FAS) 143, which is Topic 410-20 in the Accounting Standards Codification published by the Financial Accounting Standards Board. Entities covered by International Financial Reporting Standards (IFRS) apply a standard called IAS 37 to AROs, where the AROs are called “provisions”. ARO accounting is particularly significant for remediation work needed to restore a property, such as decontaminating a nuclear power plant site, removing underground fuel storage tanks, cleanup around an oil well, or removal of improvements to a site. It does not apply to unplanned cleanup costs, such as costs incurred as a result of an accident.

Firms must recognize the ARO liability in the period in which it was incurred, such as at the time of acquisition or construction. The liability equals the present value of the expected cost of retirement/remediation. An asset equal to the initial liability is added to the balance sheet, and depreciated over the life of the asset. The result is an increase in both assets and liabilities, while the total expected cost is recognized over time, with the accrual steadily increasing on a compounded basis.

An asset retirement obligation (ARO) is a legal obligation that is associated with the retirement of a tangible, long-term asset. It is generally applicable when a company is responsible for removing equipment or cleaning up hazardous materials at some agreed-upon future date.

The purpose of asset retirement obligations is to act as a fair value of a legal obligation that a company undertook when it installed infrastructure assets that must be dismantled in the future (along with remediation efforts to restore their original state). The fair value of the ARO must be recognized immediately, so the present financial position of the company is not distorted; however, it must be done reliably.

AROs ensure that known future problems are planned for and resolved. In the real world, they are utilized mainly by companies that typically use infrastructure in their operations. A good example is oil and gas companies.

Calculating AROs

When a company installs a long-term asset with future intentions of removing it, it incurs an ARO. To recognize the obligation’s fair value, CPAs use a variety of methods; however, the most common is to use the expected present value technique. To use the expected present value  technique, you will need the following:

  • Discount Rate

Acquire a credit-adjusted, risk-free rate to discount the cash flows to their present value. The credit rating of a business may affect the discount rate.

  • Probability Distribution

When calculating the expected values, we need to know the probability of certain events occurring. For example, if there are only two possible outcomes, then you can assume that each outcome comes with a 50% probability of happening. It is recommended you use the probability distribution method unless other information must be considered.

To calculate the expected present value of an ARO, companies should observe the following iterative steps:

  • Estimate the timing and cash flows of retirement activities.
  • Calculate the credit-adjusted risk-free rate.
  • Note any increase in the carrying amount of the ARO liability as an accretion expense by multiplying the beginning liability by the credit-adjusted risk-free rate for when the liability was first measured.
  • Note whether liability revisions are trending upward, then discount them at the current credit-adjusted risk-free rate.
  • Note whether liability revisions are trending downward, then discount the reduction at the rate used for the initial recognition of the related liability year.
Management Notes

Accounts Receivable

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Accounts receivable (AR) is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivables are listed on the balance sheet as a current asset. AR is any amount of money owed by customers for purchases made on credit.

Accounts receivable refers to the outstanding invoices a company has or the money clients owe the company. The phrase refers to accounts a business has the right to receive because it has delivered a product or service. Accounts receivable, or receivables represent a line of credit extended by a company and normally have terms that require payments due within a relatively short time period. It typically ranges from a few days to a fiscal or calendar year.

Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes

Companies record accounts receivable as assets on their balance sheets since there is a legal obligation for the customer to pay the debt. Furthermore, accounts receivable are current assets, meaning the account balance is due from the debtor in one year or less. If a company has receivables, this means it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.

Good accounting requires that an estimate should be made for any amount in Accounts Receivable that is unlikely to be collected. The estimated amount is reported as a credit balance in a contra-receivable account such as Allowance for Doubtful Accounts. This credit balance will cause the amount of accounts receivable reported on the balance sheet to be reduced. Any adjustment to the Allowance account will also affect Uncollectible Accounts Expense, which is reported on the income statement.

Special uses

Companies can use their accounts receivable as collateral when obtaining a loan (asset-based lending). They may also sell them through factoring or on an exchange. Pools or portfolios of accounts receivable can be sold to third parties through securitization.

For tax reporting purposes, a general provision for bad debts is not an allowable deduction from profit a business can only get relief for specific debtors that have gone bad. However, for financial reporting purposes, companies may choose to have a general provision against bad debts consistent with their past experience of customer payments, in order to avoid over-stating debtors in the balance sheet.

Accounts receivables process

While the process of accounts receivables differs from business to business, we have listed common things that you will get to see in accounts’ receivables process followed by most businesses.

  • Capturing or recording the credit days or due date.
  • Invoicing the customer on credit as per the credit policy.
  • Follow-up and collection schedule.
  • If there are any cash discount for early payment, the relevant adjustment to receivables account needs to be made.
  • Sending reminder letter with the details of bills that are pending.
  • Generating the overdue bills and the ones that are pending from the longer time.
  • On receiving payment, account the receipt and adjust the receivables accordingly.

Risks of Outstanding Accounts Receivable Balances

Cash flow deficiencies: A business needs cash flow for its operations. Selling on credit may boost revenue and income, but it offers no actual cash inflow. In the short term, it is acceptable, but in the long term, it can cause the company to run short on cash and have to take on other liabilities to fund operations.

Uncollected debt: High A/R that goes uncollected for a long time is written off as bad debt. This situation occurs when customers who purchase on credit go bankrupt or otherwise do not pay the invoice.

Management Notes

Preparation of Financial statement, General-purpose financial statements

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Preparing general-purpose financial statements; including the balance sheet, income statement, statement of retained earnings, and statement of cash flows; is the most important step in the accounting cycle because it represents the purpose of financial accounting.

Preparation of your financial statements is one of the last steps in the accounting cycle, using information from the previous statements to develop the current financial statement.

The preparation of financial statements involves the process of aggregating accounting information into a standardized set of financials. The completed financial statements are then distributed to management, lenders, creditors, and investors, who use them to evaluate the performance, liquidity, and cash flows of a business. The preparation of financial statements includes the following steps (the exact order may vary by company).

In other words, the concept financial reporting and the process of the accounting cycle are focused on providing external users with useful information in the form of financial statements. These statements are the end product of the accounting system in any company. Basically, preparing these statements is what financial accounting is all about.

Preparing general-purpose financial statements can be simple or complex depending on the size of the company. Some statements need footnote disclosures while other can be presented without any. Details like this generally depend on the purpose of the financial statements.

For instance, banks often want basic financials to verify a company can pay its debts, while the SEC required audited financial statements from all public companies.

Financial statements are prepared by transferring the account balances on the adjusted trial balance to a set of financial statement templates. We will discuss the financial statement form in the next section of the course.

Step 1: Verify Receipt of Supplier Invoices

Compare the receiving log to accounts payable to ensure that all supplier invoices have been received. Accrue the expense for any invoices that have not been received.

Step 2: Verify Issuance of Customer Invoices

Compare the shipping log to accounts receivable to ensure that all customer invoices have been issued. Issue any invoices that have not yet been prepared.

Step 3: Accrue Unpaid Wages

Accrue an expense for any wages earned but not yet paid as of the end of the reporting period.

Step 4: Calculate Depreciation

Calculate depreciation and amortization expense for all fixed assets in the accounting records.

Step 5: Value Inventory

Conduct an ending physical inventory count, or use an alternative method to estimate the ending inventory balance. Use this information to derive the cost of goods sold, and record the amount in the accounting records.

Step 6: Reconcile Bank Accounts

Conduct a bank reconciliation, and create journal entries to record all adjustments required to match the accounting records to the bank statement.

Step 7: Post Account Balances

Post all subsidiary ledger balances to the general ledger.

Step 8: Review Accounts

Review the balance sheet accounts, and use journal entries to adjust account balances to match the supporting detail.

Step 9: Review Financials

Print a preliminary version of the financial statements and review them for errors. There will likely be several errors, so create journal entries to correct them, and print the financial statements again. Repeat until all errors have been corrected.

Step 10: Accrue Income Taxes

Accrue an income tax expense, based on the corrected income statement.

Step 11: Close Accounts

Close all subsidiary ledgers for the period, and open them for the following reporting period.

Step I2: Issue Financial Statements

Print a final version of the financial statements. Based on this information, write footnotes to accompany the statements. Finally, prepare a cover letter that explains key points in the financial statements. Then assemble this information into packets and distribute them to the standard list of recipients.

Management Notes

Public Company reporting requirements

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In June 2018, the Indian government notified the Companies (Significant Beneficial Ownership) Rules, 2018 (the “SBO Rules”) imposing reporting obligations on individuals having significant beneficial ownership in companies However, the SBO Rules did not provide a great deal of clarity on the nature and extent of disclosure, and therefore, the reporting obligation was put on hold.

Pursuant to consultations with various stakeholders, the Indian government has notified the Companies (Significant Beneficial Ownership) Amendment Rules, 2019 the (“SBO Amendment Rules”).  Now, a “significant beneficial owner” will mean any individual (acting alone or together or through one (1) or more persons or a trust) who possesses one (1) or more of the following rights in an Indian company (the “Reporting Company”):

  • Holds indirectly, or along with any direct holdings, at least 10% of the shares;
  • Holds indirectly, or along with any direct holdings, at least 10% of the voting rights in the shares;
  • Holds indirectly, or along with any direct holdings, the right to receive at least 10% of the total distributable dividend or any other distribution in a financial year; or
  • Has the right to exercise or actually exercises significant influence or control other than by virtue of his or her direct shareholding. For this purpose, “significant influence” has been defined as the power to participate in the financial and operating policy decisions of the reporting company.

In respect of the foregoing rights, the SBO Amendment Rules clarify that an individual cannot be considered as a significant beneficial owner if he or she holds the above-mentioned rights or entitlements directly.  Further, the SBO Amendment Rules define the term “indirectly” in respect of each possible category of member of a Reporting Company apart from an individual.  For instance, if the member is a body corporate, the individual must hold either a majority stake in that body corporate or a majority stake in the ultimate holding company of such body corporate.  For this purpose, a “majority stake” will mean holding:

  • More than 50% of the equity share capital of the body corporate;
  • More than 50% of the voting rights in the body corporate; or
  • The right to receive more than 50% of the distributable dividend or any other distribution by the body corporate.

The deadline for significant beneficial owners to report significant beneficial ownership interest to their respective Reporting Companies under Form No. BEN-1 has been set as May 9, 2019.  This reporting obligation is not applicable, among others, to alternate investment funds, real estate investment funds and government owned entities or local authorities.  Upon receipt of the disclosure, the Reporting Company will have to comply with obligations of maintaining registers and filing returns as per the SBO Rules.

In our view, the SBO Amendment Rules provide much needed clarity on the meaning of significant beneficial ownership, enabling such owners and Reporting Companies to identify whether their interest is required to be reported. Moreover, while the compliance burden still remains, the streamlining of the definition of indirect holdings has exempted a large number of individuals who were previously considered to be included under the purview of the SBO Rules.

Verification of registered office address

The Indian government has introduced a reporting requirement for verification of the details of the registered office of an Indian company.  Pursuant to the new requirement, all companies incorporated on or before December 31, 2017 will be required to file Form INC-22A on or before April 25, 2019 and provide the following:

  • Latitude and longitude of the registered office address;
  • Photograph of the registered office showing the inside and outside of the building;
  • Photograph of at least one (1) director or key managerial personnel, who will affix his or her signature on the form, while such director or key managerial personnel is inside the registered office;
  • E-mail address of the company; and
  • Details of the current statutory auditors, cost auditors, company secretary, chief financial officer and directors of the company.

This requirement will not apply to companies which:

(i) Have been struck off from the register of companies

(ii) Are in the process of being struck off

(iii) Are under liquidation

(iv) Have been amalgamated or dissolved.

If a company fails to file Form INC-22A before the due date, it will not be permitted to file various other e-forms mandatorily required under the Act until Form INC-22A has been duly filed along with a penalty of INR10,000 (Indian Rupees Ten Thousand).

The objective behind introducting this reporting requirement is to ensure that companies maintain active and operational registered offices.  In our view, this reporting requirement is unlikely to achieve this objective, as practically speaking, there is no way for the authorities to verify whether the address provided by a company actually continues to function as the registered office over a period of time.  Moreover, the requirement for providing photographs of the director and the office building appear to be unnecessary and cumbersome.

Reporting for dealings with MSEs

In November 2018, the Indian government had directed all companies who receive goods or services from MSEs (which are defined based on capital investments and turnover thresholds) and have delayed payments to such MSEs beyond forty-five (45) days from the date of acceptance of such goods or services to file a half-yearly return disclosing the details of such pending dues.

Now, the Indian government has directed all companies to provide details of amounts due to MSEs beyond forty-five (45) days as on January 22, 2019 in MSME Form 1 along with reasons for the delay in payment.  This reporting will have to be made within thirty (30) days of the date on which the Indian government notifies MSME Form 1, which is pending to be notified as on date.

Moreover, companies will also be required to file details of pending dues by October 31 of each year in respect of dues outstanding during the period from April to September and by April 31 for the period from October to March.

This reporting requirement has been introduced to ensure that MSEs, which do not have access to a large amount of capital, receive payment for their goods and services in a timely manner.  However, in our view, the requirement for filing the return every six (6) months will increase the compliance burden on companies.

  Regulations Disclosure Requirements Frequency
1. SEBI (LODR Regulations 2015 read with SEBI (LODR) Regulations, 2018/19 – Regulation 23(9) – latest amendment-

Disclosures of related party transactions are required to be made on consolidated basis in the format specified in the relevant accounting standards for annual results to the stock exchanges and publish the same on its website

 Within 30 days from the date of publication of its standalone and consolidated financial results for the half year.
Regulation 30

The Board of Directors of the listed entity shall authorize one or more Key Managerial Personnel for the purpose of determining materiality of an event or information and for the purpose of making disclosures to stock exchange(s) under this regulation and the contact details of such personnel shall be also disclosed to the stock exchange(s) and as well as on the listed entity’s website.

  

Event Based
Regulation 31A

All entities falling under promoter and promoter group shall be disclosed separately in the shareholding pattern appearing on the website of all stock exchanges having nationwide trading terminals where the specified securities of the entity are listed, in accordance with the formats specified by SEBI.

  

Within 21 days from the end of each quarter.
Regulation 32 (7A)

Where an entity has raised funds through preferential allotment or qualified institutions placement, the listed entity shall disclose every year, the utilization of such funds during that year in its Annual Report until such funds are fully utilized.

  

Every Year
Regulation 33 (3)(g)

The listed entity shall also submit as part of its standalone and consolidated financial results for the half year, by way of a note, statement of cash flows for the half-year.

  

Half Yearly Disclosure is required to be made alongwith submission of Financial Results.
Regulation 36 (5)

The notice being sent to shareholders for an annual general meeting, where the statutory auditor(s) is/are proposed to be appointed/re-appointed shall include the following disclosures as a part of the explanatory statement to the notice:

(a)  Proposed fees payable to the statutory auditor(s) along with terms of appointment and in case of a new auditor, any material change in the fee payable to such auditor from that paid to the outgoing auditor along with the rationale for such change;

(b) Basis of recommendation for appointment including the details in relation to and credentials of the statutory auditor(s) proposed to be appointed.

  Alongwith Explanatory Statement to AGM Notice.
2. SEBI (Prohibition of Insider Trading) Regulations, 2015 (Last amended on September 17, 2019) Notification on Reporting of Code of Conduct Violations a) As per The board of directors of a listed company are required to make a fair disclosure of unpublished price sensitive information by formulating a policy as prescribed under Regulation (2A) read with regulation 8 and schedule A (under code of fair disclosure) to these regulations [Inserted by SEBI (Prohibition of Insider Trading) (Amendment) Regulations, 2018] Event Based
b) As per Regulation 6 the disclosure is to be made by the concerned person regarding trading of securities which include trading in derivatives and their traded value.

Note: The disclosures are to be maintained by the company for atleast 5 years.

 Event Based
c) Regulation 7 (2)-

– Every promoter, member of promoter group, designated person and director of the company is required to disclose to the company the number of shared acquired/disposed of.

– Every company shall disclosed regarding the above mentioned transaction to the concerned stock exchange

 –    Within trading days of such transaction.

–    Within 2 trading days from the receipt of disclosure/ from becoming aware of such information.
3. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009

(Last amended on February 12, 2018)

 a) As per Regulation 57– Letter of offer shall contain all material disclosures as specified in Schedule VIII of these regulations. Event based
b) As prescribed under Regulation 73; the Issuer shall disclose the details of the issue in the explanatory statement to the notice of General Meeting proposed for passing special resolution. Event based
c) As per Regulation 103 read with Schedule XIX; all material disclosures relating to issue of Indian Depository Receipts which are true, correct and adequate so as to enable the applicants to take an informed investment decision are required to be disclosed in prospectus and abridged prospectus. Event Based
4. SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 [Last amended on July 29, 2019] See circular SEBI/HO/CFD/DCR1/CIR/P/2019/90 dated 07.08.2019 regarding Disclosure of reasons for encumbrance by promoter of listed companies.

– The listed companies shall disclose the contents of Annexure – II on their websites

 – Event Based

– Within two working days of receipt of such disclosure.
5. SEBI (Depositories and Participants) Regulations, 2018 [Last amended on June 04, 2019] Regulation 31- The disclosure requirements and corporate governance norms as specified for listed companies shall mutatis mutandis apply to a depository. Half yearly
Regulation 76(2)-

– Every Issuer shall submit audit report for the purposes of reconciliation of the total issued capital, listed capital and capital held by depositories in dematerialized form, the details of changes in share capital during the quarter and the in-principle approval obtained by the issuer from all the stock exchanges where it is listed in respect of such further issued capital.

– The issuer shall bring to the notice of the depositories and the stock exchanges, any difference observed in its issued, listed, and the capital held by depositories in dematerialised form

 – Quarterly Basis

– immediately on occurrence of such Event
– Schedule 3 – Part C (iv) – Key management personnel of the depository shall disclose as determined by the depository, all their dealings in securities, directly or indirectly, to the governing board/regulatory oversight committee/ Compliance Officer. – on periodic basis(which could be monthly)
– Schedule 3 – Part C (v) – a) All transactions in securities by the directors and their relatives shall be disclosed to the governing board of the depository.

b) All directors shall also disclose the trading conducted by firms/corporate entities in which they hold twenty percent or more beneficial interest or hold a controlling interest, to the regulatory oversight committee.

– Schedule 3 – Part C (vii) – All directors and key management personnel shall disclose to the governing board any fiduciary relationship in any depository participant or RTA; in case shareholding exceeds five percent in any listed company or in other entities related to the securities markets; any other business interests.

 – Not Specified

– Event Based

– upon assuming office and during their tenure in office

– Event Based
6. SEBI (Foreign Portfolio Investor) Amendment Regulations 2019 Regulation 21(3): A foreign portfolio investor shall fully disclose to the Board any information concerning the terms of and parties to off-shore derivative instruments, by whatever names they are called, entered into by it relating to any securities listed or proposed to be listed in any stock exchange in India. Event based
Regulation 28: A foreign portfolio investor, or any of its employees are required to make disclosure of its interest in any security in publicly accessible media including long or short position in the said security has been made. Event based
7. SEBI (Buy-back of Securities) Regulations 2018 [Last amended on July 29, 2019] Regulation 5 (iv) read with Schedule I to these regulations and Section 68(3) of the Companies Act 2013 – Companies are required to disclose all material facts and details relating to buy-back in the explanatory statement to be annexed with  Notice for General Meeting. Event Based
As prescribed under Regulation 16 (iv) companies are required to make disclosures regarding buy-back by making public announcement. Such announcement shall also include disclosures regarding brokers or stock exchange through which the buy-back is to be made. Within two working days from the date of passing of board/special resolution.
8. Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 [Last amended on June 04, 2019] As per Regulation 21– the recognised stock exchange(s) and the recognised clearing corporation(s) shall disclose to the Board(SEBI), in the format specified by the Board, their shareholding pattern on a quarterly basis. Within fifteen days from the end of each quarter.
As prescribed under Regulation 27 (5);

The compensation given to the key management personnel shall be disclosed in the report of the recognised stock exchange or recognised clearing corporation under section 134 of the Companies Act, 2013.

 To be disclosed in Board’s Report.
9. SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013 [last amended on October 09, 2018] Regulation 5-

All material disclosures which are necessary for the subscribers of the non-convertible redeemable preference shares are required to be made in offer documents.

  

–   Event Based
Regulation 16 (3)-

Where the issuer has disclosed the intention to seek listing of non-convertible redeemable preference shares issued on private placement basis, the issuer shall forward the listing application along with the disclosures as specified in Schedule I of these regulations to the recognized stock exchange.

  

–   Within fifteen days from the date of allotment of such non-convertible redeemable preference shares.
Regulation 18 (1)

 

The issuer making a private placement of non-convertible redeemable preference shares and seeking listing thereof on a recognized stock exchange shall make disclosures as specified in Schedule I of these regulations accompanied by the latest Annual Report of the issuer.

  

 

–   Event Based
10. SEBI (Delisting of Equity Shares) Regulations, 2009 – [last amended on July 29, 2019] Regulation 7(1)(d)

In a case falling under clause (a) of regulation 6 (Delisting from only some of the recognised stock exchanges); the fact of delisting shall be disclosed in the first annual report of the company prepared after the delisting

  

–   In first Annual report of the company after delisting.
Regulation 8 (1A)

Prior to granting approval under clause (a) of sub-regulation (1) for delisting of shares, the Board of Directors of the company shall,-

(i)    make a disclosure to the recognized stock exchanges on which the equity shares of the company are listed that the promoters/acquirers have proposed to delist the company;

(ii)  appoint a merchant banker to carry out due-diligence and make a disclosure to this effect to the recognized stock exchanges on which the equity shares of the company are listed;

 On occurrence of event.
11. Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008 [Last amended on May 07, 2019] Regulation 19 (3) –

Where the issuer has disclosed the intention to seek listing of debt securities issued on private placement basis, the issuer shall forward the listing application along with the disclosures specified in Schedule I (of the said regulations) to the recognized stock exchange.

 –   Within fifteen days from the date of allotment of such debt securities.
Regulation 23(2) –

Every rating obtained by an issuer shall be periodically reviewed by the registered credit rating agency and any revision in the rating shall be promptly disclosed by the issuer to the stock exchange(s) where the debt securities are listed.

 – On occurrence of event
12. Other Disclosures through various circulars and notifications issued by SEBI recently a) Every listed company is required to disclose the default done by the company vide circular no. LIST/COMP/29/2019-20 dated 24.09.2019 – Event based in terms of Regulation 30(1) and 30(2) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 and all amendments and circulars issued thereunder.
b)      Every listed company is required to disclose the defaults on payment of interest/ repayment of principal amount on loans from banks/ financial institutions and unlisted debt securities vide circular No. SEBI/HO/CFD/CMD1/CIR/P/2019/140 dated November 21, 2019 – The disclosure shall be made promptly, but not later than 24 hours from the 30th day of such default.

Management Notes

Revenue recognition Certain Customer Right’s & Obligations

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IFRS 15 specifies how and when an IFRS reporter will recognise revenue as well as requiring such entities to provide users of financial statements with more informative, relevant disclosures. The standard provides a single, principles based five-step model to be applied to all contracts with customers.

IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after 1 January 2018. On 12 April 2016, clarifying amendments were issued that have the same effective date as the standard itself.

Contracts with customers will be presented in an entity’s statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment.

A contract liability is presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring the related good or service to the customer.

Where the entity has performed by transferring a good or service to the customer and the customer has not yet paid the related consideration, a contract asset or a receivable is presented in the statement of financial position, depending on the nature of the entity’s right to consideration. A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for example future performance of the entity. A receivable is recognised when the entity’s right to consideration is unconditional except for the passage of time.

Contract assets and receivables shall be accounted for in accordance with IFRS. Any impairment relating to contracts with customers should be measured, presented and disclosed in accordance with IFRS 9. Any difference between the initial recognition of a receivable and the corresponding amount of revenue recognised should also be presented as an expense, for example, an impairment loss.

Disclosures

The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Therefore, an entity should disclose qualitative and quantitative information about all of the following:

  • Its contracts with customers;
  • The significant judgments, and changes in the judgments, made in applying the guidance to those contracts;
  • Any assets recognised from the costs to obtain or fulfil a contract with a customer.

Entities will need to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements. An entity should aggregate or disaggregate disclosures to ensure that useful information is not obscured.

In order to achieve the disclosure objective stated above, the Standard introduces a number of new disclosure requirements.

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